National Association of Home Builders Discusses Economics and Housing Policy

(This post is part of a series of entries examining the Deficit Commission Co-Chairs’ Proposal. For the first post in the series, please start here.)

In previous posts, I identified the marginal tax rates that are being proposed as part of the tax reform proposals in the deficit commission’s discussion draft. I called the set of rates in the draft the most “optimistic scenario” because to believe tax rates could lowered significantly, one must believe that repealing all tax expenditures would in fact raise as much revenue as summing the tax expenditure estimates together suggests ($1.1 trillion according to the discussion draft).

However, research by economists has demonstrating that this result is implausible. Summing tax expenditure estimates, as the report does, produces some double counting of potential revenue. More importantly, revenue estimates (estimates of what the government is expected to collect under a policy change) allow micro-behavior responses, thereby more accurately reflecting taxpayers’ changes in economic activity (on the other hand, macroeconomic effects, or dynamic scoring effects, are still ignored for revenue estimates).

Tax expenditure estimates assume no micro nor macro behavior at all – they are double-static estimates to coin a phrase. From these facts, we can conclude that a corresponding set of revenue estimates for repealing all of these tax expenditures is unlikely to generate the $1.1 trillion per year the co-chairs report, thus requiring higher marginal tax rates than promised in the draft.

The proposed low tax rates reported by the chairs raises another point that is often confused in discussions of tax reform. It is a mistake to believe that the low rates promise tax cuts – that is, lower tax liabilities. The proposal from the co-chairs is in fact a plan for a tax increase. Tax revenue collected by the federal government would increase from just over 18% of GDP (about the 40-year historical average) to up to approximately 21% of GDP in a decade.

More tax revenue is collected because the promised low rates are assessed against a broader taxable income base. While many economists argue that lower marginal tax rates spur business activity by rewarding entrepreneurship, a claim I am sympathetic to, it is also important to keep in mind that under the proposal average tax rates (that is, effective tax rates or total taxes paid divided by income ) would go up. When evaluating the impact of a tax reform proposal, analysts should note the changes in both marginal and average tax rates by income and age classes.

And of course one reason the average rate for many taxpayers is higher is the elimination of all itemized deductions under Plan Zero. By no longer allowing deductions for items like total mortgage interest paid or real estate taxes, homeowners will report higher taxable income even if paying at reduced tax rates.